What a difference a year makes. It was about a year ago that I last wrote about Joy Global, the manufacturer of mining equipment. (read here). At that time I was detailing some bullish call activity the result of take-over rumors when the stock was making new 52 week highs.
Since then, the stock is down 43% on the year and down 60% from the 52 week highs the result of what can only be called a crash in industrial commodities.
Whatever the reason, a QE unwind, dollar strength, weak emerging market demand, it really doesn’t matter. Most miners and those who sell into the vertical have been demolished in lock step with the underlying commodities and there are few signs at the moment that there will be a pick up in demand, or other structural reasons as to why commodities should rise in the near future.
While this dire price action and outlook will likely result in bankruptcies and the equity of many publicly traded companies going to zero, JOY’s current sales, earnings and its balance sheet make it unlikely that it will be on that list. Even with what is expected to be a 40% drop in sales from their 2012 peak, and a 70% drop in earnings. The stock’s $2.6 billion market cap, with $1.3 billion in debt and close to $200 million in cash makes for a reasonable leverage ratio if we’re nearing the trough of a cycle. In some ways you can say that JOY is ground zero for the issues facing U.S. multi-nationals, with almost two thirds of their sales from overseas, dollar strength has compounded the decline demand from emerging markets like China and commodity dependent regions like Australia.
Just as it is nearly impossible to call a top in a stock it is nearly as hard to call a bottom. But the key word there is nearly. Few stocks go to zero. And while some of the price action in these names suggest it’s a possibility, it’s a fairly low probability.
So what’s the trade? Options prices have shot up as late as one would expect with the precipitous decline in the stock, but they remain well below the 52 week lows. Holders of the stock aren’t in a total panic, yet.[caption id="attachment_55661" align="aligncenter" width="600"] JOY 1yr chart of 30 day at the money implied vol from Bloomberg[/caption]
For comparison sake, copper miner Freeport-Mcmoran (FCX) traders do seem to be panicking a bit, reaching aggressively for puts and causing options prices to blowout to new 52 week and multi-year highs:[caption id="attachment_55662" align="aligncenter" width="600"] FCX 1yr chart of 30 day at the money IV from Bloomberg[/caption]
The idea of selling puts to buy calls sounds attractive, but doesn’t look great as puts look dollar cheap.
I would add that the long term chart shows the double bottom low of just below $20 in 2008/2009, I would suggest that this should be formidable technical support:[caption id="attachment_55666" align="aligncenter" width="600"] JOY 11 year chart from Bloomberg[/caption]
In my mind you have $6 or $7 risk in the event of a total commodity Armageddon, but the cost to own near the money calls, and define risk seems very reasonable. For instance with the stock at $26.00, the October 26 calls can be bought for $1.95, or 7.5% of the underlying stock price. That seems like a very good risk reward for those looking to express a contrarian bullish view. Especially when you consider the stock was trading above your break-even at $27.95 on Thursday.
Trade: JOY ($26.10) Buy Oct 26 call for $1.95
Break-Even on Oct Expiration:
Profits: profits unlimited above 27.95
Losses: up to 1.95 below 27.95 and total loss below 26
Rationale: This is a contrarian play in a stock with horrible price action and sentiment. Going out to October gives us some time, even if our entry is off slightly and even though vol is elevated options seem dollar cheap compared to how the stock is actually trading. If we do get a reversal soon we’d look to spread the calls or even close them is the snap back is big enough.
We’re starting small here as we’re not totally convinced where the reversal would come from, but we want to at least be there small if it’s soon.